So the Bernanke Fed has finally launched its next great economic experiment, undertaking to buy some $600 billion in US Treasuries over the next eight months, in addition to acquiring an estimated $250-300 billion more by way of reinvested MBS proceeds.
Monetization on this scale will mean that Tim Geithner (or whoever may end up replacing him in the aftermath of the mid-term massacre) can look forward to sending the entire bill for the Federal deficit straight to the Marriner Eccles building and not having to fret about finding a real investor to cover any part of that monstrous shortfall.
Nor will he have to worry any further about being overly polite to those hectoring foreign central bankers to whom he could otherwise have expected to flog another $400 bln or so, over the same period. Now, backed by the might of the domestic printing press, he can affect a posture of unbridled imperial arrogance in his dealings with his fractious creditors, secure in the knowledge that he can henceforth dispense with their services as committed takers of Uncle Sam’s prolific IOUs.
But, never fear, as Chairman Bernanke rushed straight from the inner sanctum to assure us via a WaPo op-ed, none of this carries any danger of sparking ‘significant’ increases in inflation – a weasel-worded categorisation which, one presumes, is to be set against the judiciously-measured increases nakedly intended as part of his contrivance to lower real interest rates.
Even more brazenly, Blackhawk Ben used his allotted column inches to enshrine the infamous ‘Greenspan Put’ explicitly into official policy by writing that:-
This approach [of buying longer-term securities] eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.
Underpinning this apotheosis of moral hazard (you know, the thing that got us into this mess in the first place), Bernanke further emphasised the Fed’s determination to keep Wall Street in bonuses by avowing that:-
We will review the purchase program regularly to ensure it is working as intended and to assess whether adjustments are needed as economic conditions change.
The madness has indeed progressed greatly from a passive observance of the false precepts of the Jackson Hole doctrine – whereby the FRB should play the role of Three Wise Monkeys in the face of a burgeoning asset bubble – to more of a Jackson Hose approach, whereby it judges policy to be successful only when it has created just such a bubble in the course of its own deliberate actions!
So the cycle of error is perpetuated, with cause and effect both being confounded and wrongly assumed to form an easily reversible reaction. The fact that rising real asset prices are a result of increasing prosperity no more guarantees that their prior, artificial inflation will subsequently augment that same prosperity than does the act of spraying your driver with champagne while he still sits on the grid make him a certainty for a podium place at the race’s conclusion.
As Sir Dudley North wrote, as long ago as 1691, in his ‘Discourse upon Trade’:-
It will be found, that as plenty makes cheapness in other things, as Corn, Wool, &c. when they come to Market in greater Quantities than there are Buyers to deal for, the Price will fall; so if there be more Lenders than Borrowers, Interest will also fall; wherefore it is not low Interest makes Trade, but Trade increasing, the Stock [wealth] of the Nation makes Interest low.
It is said, that in Holland Interest is lower than in England. I answer, It is because their Stock is greater than ours. Thus when all things are considered, it will be found best for the Nation to leave the Borrowers and the Lender to make their own Bargains, according to the Circumstances they lie under; and in so doing you will follow the course of the wise Hollanders, so often quoted on this account: and the consequences will be, that when the Nation thrives, and grows rich, Money will be to be had upon good terms, but the clean contrary will fall out, when the Nation grows poorer and poorer.
Not that we expect such tested wisdom to carry much weight in the rarefied, DSGE Councils of the Mighty today. Consequently, not the least of Bernanke’s many mistakes in implementing this shallow conjuror’s trick is the conflation of a higher nominal price for some claims to goods with that greater command over valuable, real resources to which the claims pertain which is actually the only true measure of ‘wealth’.
Simply to pump in money in order to swell the price of a parcel of farmland is not to generate any greater cultivable acreage, nor to boost the yield of the land already in existence and, hence, is not to enhance its ability to better nourish its owners or their customers. If that were only the case, we could end Man’s long battle with poverty at a stroke, simply by pencilling in a few extra, terminal zeros on the denominations of all our banknotes – a palpable fantasy by which ex-BOE MPC member Willem Buiter, for one, seems to be deliriously and incurably gripped.
Assets, after all, are claims upon actual or potential streams of an income which must never be judged solely in pecuniary terms but rather on the basis of what it contributes to the satisfaction of material human wants. If that stream of income is unaltered, the price of the asset can only make a difference to the owner’s standard of living if parts of it are broken off and sold to another, so realising an otherwise entirely notional increase.
Even then, the asset-seller’s immediate material gain must come at the cost of the buyer’s deferred benefit, unless this latter avoids such a temporary sacrifice by borrowing some newly-created, ‘fictional capital’ with which to make the purchase. Should he do this, however, it must be seen that he is only helping transfer the inflation from one involving the asset which he buys to one concerning the real goods which his seller wishes to acquire in its place.
The seller may not realise it, under the confusion of money illusion, but what he has, in fact consumed is some of his hard-won real capital. The buyer, too, seduced by the allures of a bull market, is helping to drive down the real translatable value of his own purchase in the same measure as he is pushing up its nominal cost.
Though this process may take some time to come to fruition – and though winners and losers may not be so easily disentangled, especially where the process is protracted and where titles changes hands many times at escalating prices – herein lies the essential truth of the Austrian contention that while we may be forced to take our losses in the Bust, we actually make them in the preceding Boom.
Unchallenged here goes the usual canard that in some strange way, ‘wealth’ is about destruction, not generation; i.e., that what the world is lacking is an orgy of consumption of the most final, exhaustive kind and so, if we can once inveigle or coerce people into burning, rather than building, things by fooling them as to how well off they are, economic ‘recovery’ will at last be assured.
Perhaps we should just impose candlelight and thatched roofs, ban fire insurance, and outlaw smoke alarms by way of a ‘stimulus package’.
What Bernanke and the other Nomenklatura fail to appreciate is that what must be facilitated is the selling, not the buying, of valued goods and services at a price others are willing to pay: that this is the key to wealth creation for, by this means, the vendor furnishes himself with the wherewithal to buy any of the myriad non-competing goods available to him through the efforts of all his possible counterparties while allowing him to secure whatever inputs are necessary for him to repeat this mutually enriching process in the future. Sometimes this, perforce, must include selling at a lower price than before – a necessity utterly abjured by the mainstream as comprising a maelstrom of ‘deflation’, a condition erroneously presumed to be coterminous with a self-aggravating depression.
The truth is that no amount of a macromancy aimed at shifting the monetary valuations of asset holdings can have more than a passing influence on such a continually evolving, but also continually renewing, dynamic of want-satisfactions – of the earning and enjoyment of an income.
One further unanswered question is whether the FRB moves can increase the value of US assets in anything other than the chronically depreciating dollars to which they are giving rise. If not, we are only adding another inflationary veil of illusion over a loss of, not a gain in, the value of financial capital. The undeniable fact that record low yields have done nothing to move T-Note futures beyond a TWI-adjusted, 28-year mean, while the TWI-adjusted S&P500 labours where it was back in the mid-90s, suggests this is no trivial challenge to overcome.
We might also ask whether higher asset prices will help the poor, huddled masses who have so few savings to begin with or whether lowered mortgage rates can do much to help those suffering a deficit of collateral value (i.e., negative equity) against which to refinance. Yes, it may allow some fixed-value debts to be discharged through the surrender of such newly-inflated claims as one may hold, but this is nothing which a direct renegotiation between borrow and lender could not achieve with far less risk of further distorting the overall capital structure of the economy.
If we are to place any credence in the various surveys of owners and executives at the nation’s businesses, large and small, they are sending a clear message that it is not so much the availability or the pricing of credit (or, by extension, of equity) funding that is holding them back, as much as their pervading sense of uncertainty as to what stunt their rulers and regulators will pull next and what the effect of such manoeuvres will be on them and their customers and so on their own chances of turning a profit on the capital they put at risk.
The fact that the Fed has made its programme so blatantly open-ended and expediency-driven has already triggered talk of an eventual QEIII and, moreover, has so far dispelled fears that the market impact would be one of ennui shading into disappointment, replacing this with what Mohamed El-Erian called “turbo-charging the direct policy impact before those purchases have even been specified.”
But while fine and dandy for the wealth shufflers on Wall St., for the wealth creators on Main, this could be counterproductive for the very reason alluded to in the preceding paragraph: viz., that in an economy suffering from that widespread disco-ordination of means and ends, prices and costs, which has been engendered in the Boom and then made dispiritingly concrete by the application of so many ill-advised anti-recession measures taken in its aftermath, only greater disco-ordination lies in store – not least through the pestilential effects of wild foreign exchange swings which are being disseminated across the global trading network like a Genoese hold full of black rats, or the surge in input costs which the incipient Flucht in die Sachwerte and out of the Greenback is everywhere now provoking.
Whatever our deeper misgivings, by its own rather perverted lights, the announcement has, however, enjoyed an undeniable initial success.
In local currencies, the DAX is at its highest since summer 2008: the Dow at its best since the LEH-AIG collapse. The Sensex, the KLCI, the JCI, the Philippines Composite, the Turkish 100, the Mexican Bolsa, the Chilean IGPA, and the Bovespa are all at, or close to making, new all-time highs.
Stock volatility has dropped to its lowest since the halcyon days of April; the correlation index (which tends to spike in bearish periods) is setting new post-Crisis lows, and the cumulative A/D line has never been better.
Junk bond yields are within a whisker of a five-year low of 7% while investment-grade dollar debt out to around seven years is hitting a new, generational nadir. Real yields out to 30-years are plumbing the depths, too, if only – at the longer end – thanks to resurgent break-even inflation components.
The dollar is again weaker across the board and soy, corn, canola, cotton, coffee, copper, sugar, orange juice, aluminium, silver, gold, and palladium are soaring skyward just like the EM stock markets.
In defiance of the injunction, ‘de mortuis nil nisi bonum’, we can only recall the words of then-retired BOE Governor Eddie George to the Treasury Select Committee in March of 2007 – four years after he had handed the baton seamlessly onto his willing deputy Mervyn King and just as the first cracks were appearing in the precarious CDO-sub-prime-LBO superstructure he and Alan Greenspan had helped to put in place after the Tech Bubble in which they were also instrumental:-
“You have to step back from this. You have to recognize that when you’re in an environment of economic weakness at the beginning of this decade, you only have two alternatives of sustaining demand. One was public spending, the other was consumption. We knew we were having to stimulate consumer spending. We knew we pushed it up to levels which couldn’t be sustained. That pushed up house prices. It increased household debt. My legacy to my successors has been, sort this out. We didn’t have much of a choice.”
If you listen closely, you can hear the stonemasons, already chiselling out Ben Bernanke’s legacy on the tombstone of sound money – and possibly on the mausoleum of dollar hegemony. It will be left to all of us to mourn the inheritance he has bequeathed us in his lunatic’s charter of ‘quantitative easing’ and Keynesianism à outrance.
What is left to be said? Markets are pricing on a rush from dollars first and on a response to specifics second. The ballistic nature of what this has wrought can be seen in the fact that even the silver:gold ratio has risen at an annualised rate of 223% since Bernanke lit the blue touchpaper under the rocket of Risk in mid-August. Since the end of June, Agriculture is up an annualized 187%, a climb exactly matched by Base Metals and lagged (147% annualized) by a still impressive Energy sub-component since his incendiary speech. For their part, no longer the star turn, but still impressive, Precious Metals have surged at a 110% rate so far in HII, with commodity equities (as per the TR/Jeffries index, topping them with gains at a 140% pace.
Obviously, these and many other markets are in a bubble – although its highly generalized nature tells us that this is the result not of any segmented outbreak of insanity as in 2008’s oil market, but rather of an anti-bubble in the world’s main medium of exchange, the USD – an anti-bubble being knowingly and intentionally fomented by those charged with its stewardship.
In such a world, it is difficult to know how far beyond the bounds of rationality things can run, particularly when far too many professional investors have been late to the party and when there may be a reckoning orders of magnitude greater of those who are desperate to restore their depleted fortunes by gambling that the blind Tyche can be cajoled by the central bank into favouring them, just this one last time, please. The only thing of which we can be certain is that the malign, unintended consequences of this latest assault on property rights and market pricing will far outweigh any purported good its perpetrators can ever suppose it will achieve.
I don’t think $600 billion is enough — not even with the extra $250-300 billion. It should have been at least $1 trillion, but I suppose $600 billion is better than nothing.
The point, Mr Kelly, is that even $1 would have been too much!
Perhaps, but let me ask a question.
Suppose the year is 2004. The Fed has created an excess supply of money; the market rate of interest is below the natural rate; relative prices are becoming distorted; and the capital structure is becoming unsustainable.
Now, my question: what is the least bad monetary policy?
It seems obvious: there is an excess supply of money distorting the market for loanable funds. The Fed should contract the money supply before inflation (further) distorts relative prices. Or in other words, the Fed should do negative quantitative easing.
Now suppose the year is 2010. The Fed has created a deficient supply of money; the market rate of interest is above the natural rate; relative prices are becoming distorted; and the capital structure is becoming unsustainable.
My second question: why shouldn’t the Fed expand the money supply?
Now you may disagree that we have a deficient supply of money at the moment. But many people believe this is exactly the situation we are in. If they are right, then isn’t QE2 the least bad monetary policy?
Q: How can you presume to know that the market rate is above the natural rate when across both the maturity AND the credit spectra yields are making new multi-year (even secular) lows and bond and equity issuance are positively booming?
Q: Are you aware that Austrian Money Supply is making new highs in both real and nominal terms and that – I use the concept with some trepidation – its velocity has also risen smartly (as measured by its ratio to business sales) from its temporary trough in the crisis?
Q: At what point did we liquidate or reallocate the bulk of the old malinvestments, so clearing the way for the profitable use of resources on a greater scale once more?
Q: How will promoting further, misplaced, asset-boom enticed, exhaustive spending – i.e., hidden capital consumption – help repair a deficient capital structure?
Point of information also: Mises, for one, never recommended active deflationary policy merely a cessation of further inflation – Hayek, ditto – so your pre-Crisis premise is not one with which most Austrians would be comfortable either.
Dear Mr Corrigan,
Congratulations on a splendid tour de force. I still have ‘from Gold to Goldman and friends’ on my bookshelf… now it seems we are headed back to gold.
I look forward to the day when we can leave this madness behind and we are no longer forced to speculate daily in order to prevent the constant loss of capital that is being deliberately inflicted on us. But I am afraid that now the process has to be taken through to its hyperinflationary climax before any of the malinvestment can be recognised.
Even the acolytes of moneyprinting now begin to understand the dilemma and as it begins to sink in they are in a state of blind panic. For example in discussing the possibility of a resumption of the gold standard Martin Wolf (needless to say an opponent) is quoted in his FT blog on November 2 6:38pm as follows:
“I take your point about the irrelevance of gold. But there can be no elimination of ZIRP without a policy to eliminate the debt overhang. That is really hard to do. It means writing off a large quantity of bank debt. That would probably trigger another crisis. We really are between a rock (ZIRP, etc) and a hard place (mass bankruptcy)…”
For ZIRP read moneyprinting, for probably read certainty (of total bankruptcy of HLFIs) and there we have it. In my view this is an astonishing admission of failure from a usually staunch advocate of moneyprinting in all its forms.
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